by Alexander Peace with quotes from Charles Ferguson-Davie
Sector activity has increased despite downturn, but planning and management worries remain
Old Oak Collective in North Acton was opened as the UK’s first new-build co-living community in 2016
There have been some fairly choice descriptions of co-living since it burst on to the residential scene in 2016: rabbit hutches, corporate dormitories, bedsits in the sky.
But from controversial beginnings, co-living has become increasingly established. Some 9,000 to 10,000 units have been built over the past five years, with an average increase of more than 50% year on year.
As the inner-city development market has stuttered, co-living has made up an increasingly important percentage of new starts, last year accounting for around 15% of all units approved in London. And a growing list of big names – such as BlackRock, DTZ, Cheyne and Crosstree – are backing it.
But while co-living can be profitable, it comes with more risk – both from a planning and management perspective – and that means higher costs and fewer eventual exit routes. The question is, if and when the residential market recovers, will co-living’s bubble burst?
An evolved product
In the weaker residential market there has been more co-living because, at its base, it is more viable on marginal sites: there are more units, paying higher rents, so it is more profitable. One planner called it an “intensified utilisation of space”. This has meant it can continue building during a very lean few years in London.
“We typically find a co-living project on the same site will outperform a build-to-rent block, assuming a higher operational expenditure,” says Neil MacLeod, partner at Halcyon DP – although he caveats this by saying that not every site works for co-living.
Some commentators have questioned whether this demand will continue, with developers switching back to build-to-rent (BTR) or housing for sale as the housing market improves, due to less planning risk and lower management costs.
MacLeod adds: “The question suggests co-living is only there as the residential market is so unobtainable In London. But what we have seen from residents is a desire for flexibility and convenience, and a disinclination to be caught by the liability that is a mortgage.”
MacLeod and other commentators say co-living has established its place with the other living sectors, offering a specific and in-demand rental product.
And this product is very much in demand. Knight Frank research has found that around 80 units each month are let in the average co-living scheme – four times more than in the average BTR block – and there is huge demand to back that up. Purpose-built student accommodation (PBSA) accounts for around a third of student beds in the UK, and BTR and co-living account for just 125,000 beds in a rental population of 5.8 million. Much of this stock is too large and expensive for younger renters under 35, who make up around 45% of this group.
It seems to be a message that larger developers are picking up. Several large London regeneration schemes are bringing in or considering a co-living element to broaden the rental offer on dense sites, while even the City of London has allowed office-to-co-living conversions.
“What we have seen from residents is a desire for flexibility and convenience”
neal MacLeod, Halcyon DP
What’s being offered is a far cry from the first blocks built from office-to-residential conversions. Halcyon’s minimum unit size is 18 sq m, and all are completely self-contained. This means the units appeal to a broad range of residents, who stay longer as they have all their needs met. The weighted average stay is 18 months.
Outpost runs a similar model, building units averaging 23 sq m. It works across the living sectors, with a portfolio of BTR, PBSA and co-living sites. Chief executive officer Troy Tomasik says it’s a natural extension of the rental product for people of a certain stage and position in life.
“We have pursued studio BTR-style living where we will have large-scale assets made up of studios and small one-bed apartments with a high level of amenities – that’s effectively a BTR asset – let on 12-month ASTs to young professionals,” Tomasik says.
“Within that sector we think the potential is quite large, and the market is very early in is development.”
The planning question
Planning remains a barrier, though it has got better. Harry Manley runs the planning team at Halcyon DP, and says the environment is “slowly improving”.
He says: “While planning is more difficult than other residential uses, it’s getting better and a lot of authorities have designed their own co-living policies. We track the views of different authorities and the majority give it consideration, and that’s been helped hugely by the GLA’s co-living guidance.”
Manley adds that critical to this has been the ability to show councils around built schemes – demonstrating their quality, not to mention the social environment created by communal amenities.
“Broadly, the general sentiment from local planning authorities is more open-minded and it’s a much more informed and receptive process to understanding the product,” Manley says.
Tomasik agrees: “I think the planning environment has become much more open to the idea of co-living, particularly the studio BTR variety. Having a number of operational schemes demonstrates the concept.”
Of course, those committees might not have much choice. In London, which has seen the lion’s share of co-living development, housing approvals have dropped off a cliff. For authorities that want to increase unit numbers – and particularly affordable housing – co-living, alongside student, is one of the only viable products to develop.
Last year, there were 30,154 planning approvals in London, and around 4,600 co-living units – roughly 15% of the total.
This has been helped by the working out of different methods of affordable housing contribution – as has happened in the student sector – with blocks able to offer S106 payments, intermediate co-living rents or separate blocks of affordable housing.
Management and institutionalisation
Macleod is confident about the sector’s future. He says: “Because the co-living product has matured, is more sophisticated and well designed, you are always going to have a demand to live in that building, and for institutional investors to fund that asset class.”
But while the number of operational units is increasing, there remains some way to go to prove its “institutionalisation”. Despite a host of big-name backers, there is a view the sector is in its infancy and needs to prove its stability. High-profile failures early on have not helped.
Charles Ferguson Davie, co-chief executive and chief investment officer at Moorfield Group, says: “Institutional demand and exit liquidity are not as demonstrable as with either PBSA or even multifamily BTR, where you have started to see the emergence of a secondary market with portfolios and larger standalone assets beginning to trade.”
Anecdotally, investors currently value co-living with a yield a bit wider than BTR, of around 25 basis points – what one agent called a “new sector premium”.
Davie says co-living’s high service, high amenity and all-inclusive model puts greater pressure on operations and leakage, “while the transient nature of the customer base can also risk higher resident churn and costly void periods”.
“You are always going to have a demand to live in that building, and for institutional investors to fund that asset class”
However, he adds that co-living benefits from a diverse occupier base, while shorter leases allow quicker adaptation to market conditions. Of critical importance is knowing that blocks can be managed efficiently, minimising voids and managements fees, and that longer-term wear and tear will not eat into net income.
Tomasik adds that, while the management is more intensive and expensive, with the right operations returns are similar to that of BTR.
“They are different to run from BTR blocks,” Tomasik says. “The metrics are higher density, and it comes at a higher cost per square foot to run, but from a gross to net margin it’s quite similar.”
So, despite being more profitable on paper and filling a very in-demand rental niche, the sector’s long-term prospects may rely most on perfecting its management, and proving its long-term, income-producing potential.